Withholding taxation (WHT) in view of the new beneficial owner definition. Actual economic activity requirement.
The possible restriction of withholding tax (WHT) relief
Tax alert (7/2019) | March 13, 2019
One of the most widely discussed issues among the amended provisions concerning withholding tax (WHT) is the new definition of a beneficial owner. As a result of introducing new conditions, this definition has been significantly restricted. Moreover, according to the statement of the Ministry of Finance, the criteria from the new definition can be applied even where applicable provisions do not include a beneficial owner clause. This can result in restricting the scope of exemption from withholding tax and questioning the right to apply double tax treaties in many typical examples of payments within capital groups.
- Beneficial owner and withholding tax (WHT)
- New definition in Polish tax law
- Actual economic activity and withholding tax (WHT)
- When the status of a beneficial owner matters
- What to pay attention to
Beneficial owner and withholding tax (WHT)
The concept of a beneficial owner has been developed on the basis of double tax treaties to restrict the right to enjoy the benefits granted by such treaties in situations when the payment recipient (a resident of the country being a party to the treaty) is only the formal disposer of the payment. When such recipient does not meet the criteria of a beneficial owner, certain benefits under the applicable treaty (exclusive taxation in the country of residence, reduced tax rate) are not awarded. Most commonly, such situation regards the taxation of interest and royalties – however, to apply this regulation, as a rule, it is necessary for a double tax treaty to refer directly to them.
New definition in Polish tax law
Since January 1, 2019 the definition of a beneficial owner in the CIT Act and the PIT Act has been significantly changed. According to the new definition, a beneficial owner is an entity that jointly meets the following criteria:
- it obtains an amount due for its own benefit, including that it can decide on its own on use thereof, and bears an economic risk related to loss of this amount due or its part;
- it is neither an intermediary, nor a representative, trustee, nor another subject obliged to transfer the given amount due to another subject in whole or in part;
- it carries out actual economic activity in the state of its place of residence – in the case of the amounts due gained in connection with the economic activity carried out.
The most significant change in comparison with the previous definition is introducing the requirement of carrying out actual economic activity. What is more, according to the Ministry of Finance’s statement, this requirement refers also to holding companies receiving dividends (which, as a rule, are not connected with economic activity carried out).
Actual economic activity and withholding tax (WHT)
While assessing the actual economic activity one needs to apply regulations concerning Controlled Foreign Companies (CFC). In this respect, in particular the following conditions must be taken into account:
- existence of an enterprise, within the framework of which the entity actually carries out operations, including in particular possession of premises, qualified personnel and necessary equipment;
- proportionality between the scope of activity carried out by an entity and the premises, personnel or equipment actually owned by it;
- independent performance of the enterprise’s basic economic functions using its own resources, including the executives present on site;
- the economic justification of the ownership structure and concluded arrangements.
When the status of a beneficial owner matters
The new definition applies directly while considering withholding tax exemption for interest and royalties paid between certain related entities (there are, however, doubts as to whether this is in accordance with the Interest-Royalty Directive – the legal act being implemented to the Polish legal system by the analyzed provisions).
However, it seems that tax authorities may also want to apply it in other circumstances – when the provisions of a double tax treaty include a beneficial owner clause or even to all payments in the scope of taxation of withholding tax under domestic law.
During the last consultations, the Ministry of Finance stated that even though the new regulations do not include a beneficial owner clause in circumstances where it had not previously appeared, in practice, meeting the beneficial owner criteria might be demanded every time when applying double tax treaties (and exemptions resulting from Polish tax law).
One might expect that tax authorities will demand, in case of each such payment, verification whether:
- taxpayer receives the payment for its own benefit (including whether the benefit is permanent or the payment is passed through);
- taxpayer carries out actual economic activity.
In case of lack of one of the above-mentioned requirements, applying tax exemption or reduced tax rate from a double tax treaty may be questioned.
What to pay attention to
Bearing that in mind, analyzing payments to non-residents from the perspective of the two above-indicated requirements is vital. Attention should be paid, in particular, to:
- dividend payments, especially when functions and assets of the receiving holding company are significantly limited;
- interest payments to inter-company financing entities or entities which use external financing on their own;
- royalty payment, especially in case of sub-license agreements (for instance royalty paid to a related entity that bought the license from an external supplier);
- payments of remuneration for inter-company intangible services, especially in situations when such payments are made to the invoicing entity which does not provide all of services on its own.